Blackmores: Hopes Pinned On Restructuring

Blackmores’ first half profit warning has sent analysts into a scramble to downgrade forecasts, but turnaround potential has been boosted by a shift in strategy.

-Big first half downgrade for Blackmores
-Improvement expected in second half
-Brokers like new business strategy
-But it will all take time

By Greg Peel

Dietary supplement purveyor Blackmores ((BKL)) has seen its share price fall -36% since January amidst tough conditions in the company’s premier sales destination of China. Yesterday management warned first half FY19 profit will be flat on the second half FY18, representing a material downgrade to consensus forecasts.

Blackmores’s troubles began when Beijing implemented complex new e-commerce laws in January, aimed at tightening up a loosely regulated market and requiring operators to satisfy a certification process. At the same time, the company has suffered increases in product input costs and the cost of bedding down its recent Catalent acquisition.

A cost-out program underway is tracking to expectation and Blackmores introduced significant product price rises on October 1. However, two-thirds of cost-out savings will be used to reinvest in revenue growth while price hikes always present the risk of lower sales.

But the new CEO has a cunning plan, and it is this plan that drew the attention of analysts and sent the share price higher on the day when it otherwise should have tanked. A new Business Transformation Plan targets five goals: (1) Lead with purpose; (2) Rejuvenate Australia; (3) Deliver a sustainable growth model in Asia; (4) Products and services to be powered by education; and (5) Drive operational excellence.

Which all sounds a bit “motherhood”, but backed up by management restructuring and the appointment of new executives with health sector experience and, perhaps most importantly, a Chinese managing director of the China operation with impressive e-commerce experience.

The most important of the strategy’s five goals, as analysts see it, is point (3), which is to be achieved through pursuing strategic partnerships in China. Brokers agree the potential for a Chinese partnership or joint venture would be a positive share price catalyst.

Citi believes a Chinese partner could potentially improve China distribution, tailor marketing and new development for Chinese consumers and improve regulatory capabilities.

But at this stage it is all about potential, while conditions remain challenging. Morgans echoes consensus in suggesting the business transformation program makes strategic sense and should drive solid top and bottom line growth, but given said short term challenges and a lack of actual financial targets, converting a strategic plan into earnings forecasts is rather difficult.

Thus, as is typically the case with potential turnaround stories in any industry, it all sounds good but the proof of the vitamin pill will require actual evidence.

The new CEO, in outlining the plan, pointed out Blackmores’ gross profit margins are some -500 basis points below the competition, which suggests improvements can be made. Credit Suisse notes a lot of this gap is due to product mix, implying innovation will be key to lifting margins and “that’s not a sure thing”.

Credit Suisse also notes Chinese consumers are increasingly holding off purchases – of anything presumably – until retail holidays in which deep discounts are offered, such as Singles Day – the creation of “China’s Amazon” Alibaba – June 18 – the creation of Alibaba competitor JD – and Valentine’s Day. And the new kid taking on Alibaba and JD is Pinduoduo.

Pinduoduo organises consumers into groups for the purpose of making bulk purchases at better prices than retail.

Thus competition in Blackmores’ space is fierce. Credit Suisse at least sees enough potential to move its recommendation on the stock to Neutral from Underperform.

Management is highlighting price increases, cost-outs and the benefits of the Catalent acquisition in expecting a materially better second half, but analysts see this as a big ask. Morgan Stanley retains Equal-weight but sees full year earnings at risk.

Citi is sticking with Sell, while noting an aforementioned Chinese partnership is the main risk to this recommendation.

Morgans retains Hold, but despite cutting earnings forecasts alongside other brokers, Morgans stands out in lifting its price target to $80.00 from $66.10. Ex-Morgans, the consensus target among FNArena database brokers (bearing in mind two are yet to update) is $67.20.

The broker attributes the big jump to applying a lower risk free rate (consistent with falling interest rates) and rolling forward its forecast period to FY21, which will be the first full year under the new CEO.

As to whether Blackmores can turn the ship as early as FY21 is still a point of contention among brokers.

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